For those inclined to listen, financial markets are banging on pots and pans, warning that the world is a risky place for investors.
The problem for taxpayers is that the trustees who run San Diego County’s $10.3 billion public pension fund have been slow to remove their earplugs.
Last week, global markets convulsed after Switzerland’s central bank abruptly stopped pegging its currency to the euro.
Much like U.S. government bonds, the Swiss franc is seen by investors as a haven. Switzerland has a balanced budget, strong economy and strict political neutrality.
Before the central bank capped exchange rates in 2011 (by printing francs to buy euros) the franc’s value was soaring, hurting exports and depressing local prices.
But manipulation was expensive. The central bank’s euro holdings grew to 60 percent of the nation’s entire annual economic output. Hyperinflation fears drove an unsuccessful ballot initiative to back the franc with gold.
When something can’t go on forever, it usually doesn’t. So the Swiss central bank reversed course.
Ordinarily, a 3 percent move in the currency of a developed nation relative to others is a big day. But Thursday the euro fell 30 percent against the Swiss franc, while the U.S. dollar fell 18 percent.
Some brokers offer extraordinary leverage, allowing $1 to control $50 worth of derivatives. This magnified the drama.
A British broker was wiped out after client losses exceeded its reserves. FXCM, one of the largest retail foreign-exchange brokers in the world, was rescued by a $300 million emergency infusion.
Why on earth should we care about a tiny nation’s monetary policy? It’s easy to argue currency speculators deserve what they get.
Well, because we are the speculators. Roughly 45 percent of San Diego County’s public pension system — about $4.6 billion backed by taxpayers — is invested by a single manager, Salient Partners of Houston, in a variety of futures, swaps and other derivatives. And Salient is authorized to leverage the entire, $10.3 billion portfolio by 20 percent, placing more than $12 billion at risk in markets.
I wish I could tell you how much money we lost in the euro debacle, but I can’t. Pension officials don’t routinely disclose their derivative portfolio.
In October, several weeks after I made a public records request, I finally got a glimpse at the fund’s Aug. 31 holdings.
Along with trades on the euro, Japanese yen and Australian dollar, Salient was betting on price movements in everything from zinc to coffee to Brazilian stocks.
There was even $1.1 billion at risk on credit default swaps, a form of insurance that became notorious for accelerating the 2008 financial crisis.
However, this portfolio isn’t quite as risky as it looks, at least in theory. The staggering variety of the pension fund’s derivative trades made it less likely that turmoil in any one market would sink the entire portfolio.
This extreme diversification is by design. Some markets normally move in opposite directions, so losses in zinc might be offset with gains on the yen. By using leverage to boost bets on lower-volatility assets like bonds, Salient hopes for higher returns without taking more risk.
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